New Investment Opportunities for Credit Unions: Commercial Mortgage-Backed Securities

NCUA's implementation of RegFlex on March 1, 2002 relieved many credit unions of excessive regulatory burdens and facilitated their investment in instruments such as commercial mortgage-backed securities (CMBS) that previously had been prohibited. CMBS are structures collateralized by loans that are secured by five major commercial property types: office space, retail property, industrial facilities, multifamily housing, and hotels.

 
 

NCUA's implementation of RegFlex on March 1, 2002 relieved many credit unions of excessive regulatory burdens and facilitated their investment in instruments such as commercial mortgage-backed securities (CMBS) that previously had been prohibited. CMBS are structures collateralized by loans that are secured by five major commercial property types: office space, retail property, industrial facilities, multifamily housing, and hotels.

Unlike residential MBS, CMBS carry heavy prepayment penalties, a phenomenon that makes it prohibitive for buyers to refinance during periods of declining interest rates, thereby reducing contraction risks and facilitating investors' ability to predict cash flows. CMBS also feature a sequential pay structure that prioritizes cash flows between senior and subordinate shares.

CMBS potentially carry significant credit risk because of their high concentration in a small number of loans. As a result of the ongoing poor job market and the subsequent decrease in demand for office real estate, commercial delinquency rates and the volume of CMBS downgrades have risen over the past several months. However, CMBS' upgrade/downgrade ratios continue to outperform those of corporate bonds as upgrades continue to exceed downgrades. In addition, the structures have yielded significantly higher returns than treasury bonds over the past several years, prompting increased interest among credit unions seeking greater return on their investments.

Credit unions considering investing in CMBS should evaluate the instruments' long-term impact on ALM and credit risk, their historic and expected returns compared to other instruments, and interest rate and real estate market forecasts. With a thorough assessment of these factors, credit unions can determine if CMBS' promise of mitigating ALM risk and increasing total returns outweighs the credit risk associated with investing in a highly concentrated pool of loans.

 

 

 

Jan. 19, 2004


Comments

 
 
 
  • Good to know that this is an option and how to take a basic look at the instrument.
    Anonymous
     
     
     
  • Good to explore potential options.
    Anonymous